When starting a business with a co-founder or co-founders, there’s a school of thought that suggests that each member of the founding team should be created equal – they should get a fair share of the company equity pie, split straight down the middle. However, not all companies are created equal so deciding which members of your team get more equity than others can be difficult. Add an investor into the mix and you could risk fracturing your relationships if you fail to approach equity division objectively.
When founding my own businesses I’ve been a firm believer in offering greater equity to the person that brings more to the table. In the start-up stage, for instance, the entrepreneur with the initial idea should be given a larger stake, as that first spark was the catalyst to the entire company. Another crucial factor to take into consideration is whether your founding partners are pulling their weight. Often in business you operate on a gut instinct, therefore you know instantly who is putting the most effort into running the day-to-day of your company. It is often the case with a young business that some founding members will not be able to give 100 per cent of their time to the project; they may be running other companies or working part-time to kick-start operations, which I know firsthand from forming previous businesses myself.
In these instances, you have to be realistic about your own role, the contribution you make and avoid being too precious about your own stake. You also have to be objective and evaluate the performance of your co-founders in order to fairly determine the proportion of equity that they are entitled to. If their contribution is greater than yours and if their skillset stands to generate value for the company down the line, then their stake should reflect that.
How investment changes the equity pie
You can apply a similar thought process when seeking investment, whether it is from a VC, an angel investor or a private equity house. The hands-on approach from a private investor and an experienced team could be indispensible when your company is at the crucial development capital stage, so deciding if their input or expertise will add value could determine how much equity you are prepared to offer. Doing your own due diligence and researching that investment provider thoroughly – as opposed to just chasing the highest valuation on the table – could be the difference between offering a stake of your company to an engaged investor or someone completely detached and merely driven by returns.
From an investor’s perspective, we ensure that we have a vested interest in each of the companies on our portfolio and have members of our private equity team on the board of some of our businesses. Aside from generating returns for our clients, we want to see the companies grow and develop, so regularly communicate their progression to our investor network. This again reflects the notion of bringing more to the table, so factors such as this are worth considering when making that leap and dividing up your company’s equity.
Although it might feel like the most democratic way to divide the equity pie would be an equal split between founders and a lesser proportion divvied up to an investment provider, this would not necessarily be the most constructive means of growing your business. Essentially, whether slicing the equity pie between founders or private investors, the basic principles are the same; are they fully engaged with the minutia of running your business; are they pulling their weight and bringing fresh ideas to the table; and can you see them adding value to your business in the long run? By evaluating those core elements honestly and pragmatically, you will have your company’s best interests at heart and be able to maintain solid relationships with both your founders and investors.
Luke Davis is CEO of IW Capital and co-founder of Crowdfinders.
Further reading on equity finance
